AgDM newsletter article, September 2000

Why worry about changing structure?

Neil Harlby Neil Harl, Charles F. Curtiss Distinguished Professor in Agriculture, Professor of Economics, 515.294.6354, harl@iastate.edu

Concerns about the changing structure of agriculture are widespread. Much of the worry is over mergers-the big firms are becoming larger in seed, banking, health care, manufacturing, publishing, broadcast media, and almost every economic sector or subsector.

However, it's more than increased concentration. It's also the rush to integrate vertically from top to bottom.

In fact, it's the deadly combination of concentration and vertical integration that poses a potential threat to agricultural producers. Here is why.

The stage of greatest vulnerability

In a world of high levels of concentration in input supply and in output processing and in a world where producers are vertically integrated from the top down-from meat packers to producer or from feed company to producer-the period of greatest vulnerability is when production/marketing contracts expire.

Example: let's assume meat packers are allowed to integrate vertically as Smithfield announced several months ago it intended to do. In addition, let's assume we're down to two giant packers. An independent family farmer producing hogs for one of the two vertically integrated packers comes to the end of a five-year contract. The terms offered for the new contract simply aren't acceptable, economically. What are the producer's options if the nearest slaughter plant owned by the other major firm is 200 miles away? 400 miles? 1,000 miles? Is it a meaningful option to shift to the competitor? It's difficult to argue that it is. The result,, predictably, is a take it or leave it situation. Indeed, producers with heavy fixed costs in facilities are the most vulnerable-particularly if the facilities are still encumbered by debt.

That's why the policy objective simply must be to assure meaningful, competitive options when contracts terminate-if producers are to be financially healthy, independent entrepreneurs.

One of the problems is that the antitrust system is heavily oriented toward evaluating mergers and concentration based on impacts on consumers, not the effect on producers. If it is a policy objective to work toward an economically healthy, independent group of entrepreneurs as producers, the antitrust system must be reoriented to focus attention on producers as well as on consumers.

Why vertical integration?

A question of growing importance-why the rush to integrate vertically? As with most economic developments, there is no single reason-there are several.

· First, vertical integration assures a source of supply for purchasers such as meat packers, or a ready and assured market for products for input suppliers such as seed companies. It's to improve the efficiency and bottom line of the vertical integrator. But are those efficiencies likely to be passed on to consumers? With a high level of concentration, that's doubtful.

· Second, it's to reduce the costs of acquisition rather than having a band of buyers out competing for slaughter hogs or cattle, or a band of sales personnel to move seed, fertilizer, or chemicals. It's done on a contractual basis, instead.

· Third, it's to replace open, transparent competitive markets with negotiated prices implemented by contract. Is this a good idea? Many agree that open, transparent, competitive markets are the fairest way to exchange goods. Replacing such markets with negotiated prices raises the specter of negotiating power. Few would argue that negotiation between an individual producer on one side, and a highly concentrated group of firms on the other side produces the same outcome as open, competitive, and transparent markets.

· Some say it's to deliver with greater precision what consumers want. However, that's debatable. In an early example, seed/chemical companies totally misjudged consumer acceptance of genetically engineered foods and stumbled badly in the process.

· Finally, it's to squeeze producers by shifting functions off the farm (such as marketing and risk management) and limiting even further the portion of the retail food dollar going to producers.

It's all about power

At bottom, the structural transformation of agriculture is heavily about power. It's about exploiting the market power of highly concentrated firms.

The policy issue is whether limits should be imposed on that exploitation of power and even whether limits should be imposed on the amassing of that power.

In conclusion

It is a fundamental tenet of open, market economies that firms should be free to make operations more efficient. That's one way economies grow and develop.

Nevertheless, it's been clear for more than a century that firms are not and should not be free to pursue steps to achieve and maintain economic domination. Those are relevant concerns for the agricultural sector in this new century.

 

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